3.
Break-Even Analysis
Break-even analysis is an easy "quantitative" way to analyze
opportunities. It can also be used to compare different solutions.
It gives us a way to evaluate opportunities on paper before
we invest our resources. It shows us clearly how many units we have
to sell before we will recover our costs. We can create several break-even
charts for the same opportunity varying the costs and sales numbers to
help us see what might happen with different outcomes.

Another formula provides the slope of the total cost line:Slope = Total Variable
Costs / Total Quantity
A desirable, lower slope number provides better return once we pass B-E
sales.

The B-E chart is created by drawing the "Sales" line at a 45o
angle and creating a vertical axis and a horizontal axis based on the
total sales expected for the total number of units sold. Once we
have the $ on the vertical axis and the units on the horizontal axis we
can add the line for "Fixed Costs" and then draw the
"Variable Costs" from the "Fixed Cost" line and see
where it intersects the "Sales" line. This is the B-E
point.

3.1 Example 1 - M Class First
Aid Kit StrapIn this example the customer wants to order 100,000
units that we think we can sell for $0.32
per unit after we invest $1,000 in tooling; $2,000 in engineering;
$250 in qualification and $1,000 in admin cost for a total fixed cost
of $4,250.
We estimate our variable costs at $0.21
per unit.

Cost
Element

Cost $

Tooling (Fixed)

$1000

Engineering (Fixed)

$2000

Administrative (Fixed)

$1000

Qualification (Fixed)

$250

Material (Variable)

$0.06
each

Labor (Variable)

$0.04
each

Equipment (Variable)

$0.11
each

B-E sales is 38,636
units
Slope of the variable cost line is 0.21

3.2 Example 2 - Wire WrapIn this example the customer wants to order 30,000
units that we think we can sell for $0.20
per unit after we invest $500 in tooling; $1,000 in engineering for a
total fixed cost of $1,500.
We estimate our variable costs at $0.07
per unit.

Cost
Element

Cost $

Tooling (Fixed)

$500

Engineering (Fixed)

$1000

Material (Variable)

$0.01
each

Labor (Variable)

$0.03
each

Equipment (Variable)

$0.03
each

B-E sales is 11,538
units
Slope of the variable cost line is 0.07

Test
Your PK Absorption

1. Why is
it a good idea to use break-even analysis?

2. What does break-even analysis
show us?

3. What should we do if the
break-even quantity is higher than the customer wants to order?